Best of biotech can bounce back from dotcom-style slump

by | Aug 18, 2023

By Debra Netschert, managing director at Jennison Associates

The healthcare sector is one of dynamism – where global demographic trends, breakthrough drug developments, and M&A activity can offer diverse sources of alpha. Historically, the sector has provided access to secular long-term growth and has outperformed broader market indices over full market cycles since the late 1990s. 

Innovation is modernising the industry, as technology adoption is improving the patient experience and contributing to lower costs. Patients have become more tech-savvy and more aware of their own health. At the same time, advancements in the ability to diagnose, monitor, and treat diseases with personalised therapeutics are creating a broad set of investment opportunities.

The current wave of consumerisation and innovation is paving the way for a select group of healthcare companies with access to data to generate durable, outsized growth over the next decade. In our view, moves to replace legacy approaches and provide more impactful and efficient care should parallel the evolution of the technology sector from 2010 to 2020.

Early-stage therapeutics slide

Similar to technology’s dotcom crash that preceded the sector’s decade-long run of outsized growth, the healthcare sector has experienced recent volatility. The drawdowns in early-stage therapeutics are similar to the drawdowns of less mature technology companies in the early 2000s. Performance of the biotech sector resembles that of the technology sector after the 1999 bull market, when it took nearly two years for the Nasdaq to find its footing following the 2000 crash.

While the technology sector ultimately recovered from the dotcom crash, the recovery was not uniform. Currently, there are a handful of large technology conglomerates with entrenched competitive advantages. Over the long term, we believe the biotech recovery will follow a similar pattern and expect companies with the best science to lead the way, while others simply disappear.

In the near term, though we continue to be bullish on the outlook for select companies in the biotech and therapeutics sub-sectors, our view in aggregate is nuanced and we expect alpha generation derived from bottom-up stock selection will be paramount.

Too much public company creation over the past five years fostered an environment where ‘less-than-ready’ companies were vying for capital, thus overly diluting the pool of investible ideas. Mid-cap biotech has been a more interesting source of long ideas for our team, as many of these companies have pipelines and offer positive EBITDA. These attributes make them more attractive in a rising rate environment and, more importantly, attractive to larger potential suitors.  

Active approach is paramount

Healthcare’s combination of innovation and performance dispersion among individual companies makes it a compelling space for skilled active managers. On the innovation front, advances in DNA sequencing, artificial intelligence, and computational biology in the biotech industry have translated into new treatments for chronic diseases such as diabetes and obesity. There are also early signs that more effective obesity treatments are having a positive impact on cardiovascular disease, which is among the world’s deadliest and most costly conditions to treat. 

For investors, these advancements are creating new opportunities among select pharmaceutical companies with a depth of resources – including large balance sheets and workforce – to capitalise on this enormous market for cardiovascular treatments and disease prevention.

In addition, innovation in the sector expands beyond biotech and biopharma companies. For example, a shift towards a value-based care model where costs are directly associated with the quality of the result is encouraging technology investments to increase efficiencies. Healthcare service providers are guiding this evolution through access to patient data and developing methods to monitor and optimize the delivery of care. Additionally, the forward opportunity for medical equipment appears to be improving as reduced concerns about inflation, nurse shortages, the strong dollar, and hospital spending reduce the backlog for surgical procedures. We believe this should provide above historic trend growth for well-positioned companies. 

As we look ahead, we believe the sector can continue to outperform over the long term, as investors place more emphasis on stable company fundamentals and the significant alpha generation that broad innovation can provide.

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